The two basic principles for investing in real estate are cash flow and equity build-up. Some investors lean towards creating more cash flow, some favor equity build-up, but most try to find properties that have some blend of the two that they feel comfortable with. While every investor has his or her own philosophy for investing, I personally tend to lean towards investing for appreciation.
I realize some people shutter at the idea of appreciation, so let’s call it a recovery in values. Once houses return to a level where homes can be bought and renovated at or near replacement cost, we can start calling it appreciation. In Atlanta, we are buying and fixing homes for half of replacement cost, so we have a lot of room for price recovery before we even consider appreciation.
With the ability to buy properties at or below 50% of their previous selling price just a few years ago, it would stand to reason that there is an opportunity to capitalize on recovering values. Yes, there are also tremendous opportunities to create great cash flow from these properties as well, but I personally like the idea of buying an asset that will not only generate income, but will also see a significant increase in value over the coming years.
I realize that many investors hear this and speculate that housing values may not recover for a very long time and therefore only want to invest in houses that create cashflow without regard for appreciation. While they may be right, I tend to think that basic economics will drive prices back up. In fact, if you look at a market such as Phoenix, this is already happening. Phoenix has been a hot investment market over the last few years as home values dropped dramatically from their peak in the mid 2000’s. However, just in the last year prices have increased over 30% and inventory is way down as demand from investors has consumed much of the foreclosure inventory. In fact, the chief economist for the National Association of Realtors said that “Phoenix will be a benchmark city to monitor.”
Living in Atlanta, I look at what’s happened in Phoenix over the last year and see the same fundamentals at work in my market. Our real estate inventory has declined 3 years in a row and has actually dropped a whopping 36% just since June of last year. In addition to this, demand from investors has been red hot over the last few months with closings already 12% higher this year than they were a year ago at this time. I’m no economist, but I did take Economics 101 and 102 in college and can still remember my supply and demand graphs. With a shrinking supply of houses and an increase in demand from buyers, Atlanta should experience something very similar to Phoenix in the way of increasing values.
As such, I’m an investor who believes that buying for the potential increase in real estate values makes sense. Yes, I believe that cash flow is important, but I also don’t want to stick my head in the sand and pretend that there isn’t a very real window of opportunity to buy properties with the potential for appreciation (price recovery) right now. As real estate investors, it is critically important to look around the country and study how other markets have been affected by changing market dynamics. Understanding these principles can help you decide where and how to maximize the profitability of your next investment.